Capital Controls Another Knock To Banks

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Brokers decide new prudential capital controls may limit growth for banks and curb dividends.

-ANZ, Westpac and NAB face $500m capital add-ons
-ANZ to be hardest hit by capital ratio changes to APS 222
-Big banks may be forced to cut dividends and reprice loans
-Brokers mixed on outlook for big banks

By Nicki Bourlioufas

It's not over for the big banks in meeting potentially onerous capital requirements. The banking regulator APRA is requiring further changes to capital ratios and some of the big banks are better placed than other to meet them, according to analysts.

APRA has ordered Westpac ((WBC)), ANZ Bank ((ANZ)) and National Australia Bank ((NAB)) to put aside additional capital in response to the self-assessments of their risk management and governance.

The ‘add-on' capital requirement will apply until the banks strengthen risk management and address flaws identified in their self-assessments, which follow the APRA-initiated Prudential Inquiry into the Commonwealth Bank of Australia ((CBA)). That has seen the CBA required to hold a $1bn add-ons since April 2018.

According to UBS, these add-on requirements will lead to a 16 to 18 basis point drop in Common Equity Tier 1 (CET1) capital for the banks. As part of the Basel III reforms to the capital framework introduced in 2013, APRA requires ADIs (authorised deposit-taking institution ) to hold a buffer of CET1 capital, over and above each ADI's minimum requirement.

Contagion risk control

On top of these ‘add-on' capital controls, APRA recently released its revised version of Prudential Standard APS 222, Associations with Related Entities. The updated standard is designed to further reduce the risk that problems in one part of an authorised deposit-taking institution having a "detrimental impact" on the overall group.

APRA has confirmed that it will implement its previously announced proposal for ADIs to limit exposures to related entities (including offshore units) to 25% of Level 1 Tier 1 Capital, down from 50%.

The changes take effect from January 2021. By updating and strengthening the requirements of APS 222, APRA wants to ensure ADIs are better able to monitor and control contagion risk.

The practical implication of the revised APS 222 is that the big banks will now have caps on the amount of capital that can be injected into their NZ operations. ANZ Bank, with the largest NZ exposure, is the most impacted, according to brokers.

The bank has already disclosed that it is approaching the 25% cap on current metrics ahead of the Jan 2021 implementation.

ANZ on the radar

UBS believes ANZ Bank dividend payouts will come under pressure. "The vast majority of earnings for dividends would need to come from Australia and not NZ, placing pressure on group dividends."

JP Morgan is even more downbeat. Following changes to APS 222, the broker says it has downgraded its FY20 cash earnings per share (EPS) EPS forecasts for ANZ by -0.7% and FY21 cash EPS forecast by -2.7% and also stripped dividend growth from its forecasts.

ANZ's price target has been reduced -0.4% to $27.70. JP Morgan expects no buybacks or discounts on dividend reinvestment plans (DRP) to ensure ANZ has enough capital to meet the RBNZ's forthcoming capital rules and to prevent it from breaching APS 222's 25% limit.

The banking research team at Macquarie says APRA's capital requirements are "penal" for ANZ. "We continue to believe that APRA will look to minimise the capital outflow, leaving the door open for future changes relating to NZ. Despite relative valuation attractiveness, we remain cautious on ANZ given uncertainty around NZ capital outcomes," the broker says.

Ord Minnett predicts ANZ is likely to try mitigate the impact of these changes by possibly making greater use of its NZ branches, writing more loans through the branch structure rather than the NZ subsidiary.

ANZ could also constrain growth capital allocated to the NZ unit. A potential sale of ANZ's NZ unit would need to be weighed up against the likely increase in funding costs for an independently listed NZ business against the cost of holding stranded group capital.

UBS says the banks are looking at a number of options to reduce the burden of the NZ capital proposals. "Writing loans out of the Australian branch rather than NZ business units is one option. However, it is only really effective for institutional business. Shrinking the balance sheet and repricing are also options which could be undertaken."

According to Citi, NZ capital proposals could lead to a CET1 shortfall of around -NZ$21bn by FY23. "This could prevent or delay ANZ and CBA's buy-back agendas. WBC's capital position is expected to weaken, while NAB may need to continue to place a discount on its DRP to raise sufficient capital to meet the NZ requirements," says Citi.

For Westpac, UBS expects a dividend cut. With earnings under pressure from low interest rates, subdued revenue, remediation, and credit charges bouncing off lows, UBS predicts a dividend cut for WBC to $0.84/share to be announced in the first half of 2020.

Citi says that "NZ subsidiaries will be required to build organic capital, likely through a combination of repricing and restriction of dividends paid back to the parent."

According to Credit Suisse, there is still the unknown effect of the RBNZ capital proposals and "all of these changes are making it more difficult for banks more generally to meet APRA's 10.5% ‘unquestionably strong' benchmark which commences 1 January 2020."

Big banks split on capital holdings

UBS says there is a clear split in the capital ratios of the Australian banks once announced asset sales are taken into account.

"We estimate that ANZ and CBA are well capitalised, while a number of recent announcements once again put NAB and WBC's capital ratios under threat in our view."

UBS analysis shows that following asset sales, ANZ and CBA's CET1 ratios are materially stronger than NAB's or Westpac's.

General outlook is poor

Citi expects CBA and Westpac to join ANZ and NAB in cutting dividends should interest rates continue to fall. "Warning signals such as mortgage delinquencies and personal lending arrears continue to deteriorate. Even with a stabilisation in the housing market, many customers are likely to continue to come under stress as interest-only periods expire, implying credit impairment charges could rise," says Citi.

UBS says the banks' ability to generate a lending spread and return on equity is limited. "If the housing market does not bounce back quickly, this could put material pressure on the banks' earnings prospects over the medium term, implying that the dividend yields investors are relying upon come into question once again."

In addition to APS 222 and the add-on capital requirements for Westpac, ANZ and NAB, changes to Australian Accounting Standards Board (AASB) 16 from July 2019 further impact the banks' CET1 ratios.

UBS analysis suggests the introduction of AASB 16 Leasing, which capitalises operating leases on-balance sheet, has a negative impact on CET1 of around 8 to 11 basis points.

According to FNArena's database, the consensus target price for ANZ is $27.69, suggesting 3.5% upside to the last share price. Targets range from $25.80 (Morgan Stanley) to $29.50 (Citi).

The consensus target price for CBA is $72.44, suggesting -8.1% downside to the last share price. Targets range from $66.00 (Morgan Stanley) to $77.60 (Credit Suisse).

For NAB, the target price consensus is $26.93, suggesting -1.2% downside to the last share price. Targets range from $23.00 (UBS) to $29.60 (Ord Minnett).

For Westpac, the consensus target price for is $28.50, suggesting 1.4% upside. Targets range from $24.50 (UBS) to $33.00 (Morgans).

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